The GLBA's [Gramm-Leach-Bliley] "repeal" of a portion of the Glass-Steagall Act of 1933 is said to have somehow contributed to the current financial meltdown. Nonsense.

Adopted early in the New Deal, the Glass-Steagall Act separated investment and commercial banking. It prohibited commercial banks from underwriting or dealing in securities, and from affiliating with firms that engaged principally in that business. The GLBA repealed only the second of these provisions, allowing banks and securities firms to be affiliated under the same holding company. Thus J.P. Morgan Chase was able to acquire Bear Stearns, and Bank of America could acquire Merrill Lynch. Nevertheless, banks themselves were and still are prohibited from underwriting or dealing in securities.

Allowing banks and securities firms to affiliate under the same holding company has had no effect on the current financial crisis. None of the investment banks that have gotten into trouble -- Bear, Lehman, Merrill, Goldman or Morgan Stanley -- were affiliated with commercial banks. And none of the banks that have major securities affiliates -- Citibank, Bank of America, and J.P. Morgan Chase, to name a few -- are among the banks that have thus far encountered serious financial problems. Indeed, the ability of these banks to diversify into nonbanking activities has been a source of their strength.

Most important, the banks that have succumbed to financial problems -- Wachovia, Washington Mutual and IndyMac, among others -- got into trouble by investing in bad mortgages or mortgage-backed securities, not because of the securities activities of an affiliated securities firm. Federal Reserve regulations significantly restrict transactions between banks and their affiliates.

I dunno, seems to me like it was the leveraging... banks are bound to make stupid bets from time to time, but when you're leveraged 30-1 it doesn't really leave much room for error. Plus the lenders get nervous once you make that bad bet and they start making margin calls and th bank gets stuck selling stuff on an already depressed market. Nor do I understand how any business thats leveraged that much could be rated triple A in the first place.

The real culprit was the Commodities Trading Modernization Act which exempted credit default swaps from regulation.

Like a lot of things, the CDS market contributed to the current crisis. But the Commodities Trading Modernization Act as the root cause? Don't make me laugh.

Absent the act, the entire market would have just wound up London, beyond reach of US regulation, and other points offshore. And it is precisely in the London market where the most serious CDS problems first emerged.

The root cause of the crisis is that complex mathematical models (which had never experienced a stress test in a down market) predicted that it was safe for financial companies to leverage themselves at 30-1 on securities backed by $500,000 125% LTV-mortgage loans to immigrant house painters who could not document their income, but could demonstrate that they had paid all their bills on time and responsibly used their $500 credit line from the local equivalent of JC Penny. Many financial company executives worldwide, ranging from frontline mortgage brokers, to high-flying executives of Wall Street investment houses, to the risk managers of conservative state-owned German Landesbank , allowed the computer software incorporating these models to make their buying, purchasing and lending decisions for them.

The resulting relaxation of lending standards for home mortgages resulted in a rush of speculative investment in residential real estate. A bubble. When prices were finally pushed so high by speculation that nobody was left who wished to buy a home as shelter instead of as a get-rich-quick scheme, the bubble popped and prices began to crash. This triggered a wave of mortgage defaults unprecedented since the Great Depression. More important than the number of defaults, though, is the losses taken with each default. These exceeded the most wildly pessimistic estimates contained within the mathematical models described above, triggering an even BIGGER collapse in the value of the mortgage-backed securities, as the holders realized they were actually at substantial risk of losing some of the underlying principal, not just an occasional coupon payment as the models claimed.

The computer models certainly were a part of it. The crisis ultimately was caused by failure of risk analysis and driven by perverse incentives created by FM/FM (with a kick-start from the Community Reinvestment Act). FM/FM created a market for subprime mortgages, allowing the originating banks to offload and be free of them following a nice little cut. FM/FM could get enough cash to by buy these mortgages (and dig themselves into a dangerous hole) because they had the implicit backing of the US government. The real risk distortion came when those subprime mortgages were magically transformed into "good" debt backing derivatives. Except they weren't. And this whole process created a positive feedback loop of real estate asset inflation. Then the music stopped...

I don't think it's accurate to say FM/FM created the market for subprime mortgages, though they certainly participated. They could have been more prudent - much more prudent - but the market for the stuff was there anyway.

The investment bankers borrowed on the commercial paper market, and leveraged up to 30 times their underlying capital, but that market began to fall apart in July. Apparently money market funds (which transacted through captive banks) were not enough. So now the investment banks have become part of bank holding companies in order to get access to the cheaper capital of CDs and low-interest savings and checking accounts. So the chickens of Glass-Steagall repeal have yet to come to roost.

Let's all make a deal. The left doesn't blame Gramm-Leach-Bliley, the right doesn't blame the Community Reinvestment Act. Indeed, let's forget about affixing blame entirely and figure out how the heck to get out of this mess.

The idea that that the CTMA caused the banking crisis in moronic, because the idea that credit default swaps caused the banking crisis is moronic.

We just had the largest bankruptcy in history - Lehman Brothers. There over $400 billion (notional amount) of credit default swaps outstanding on Lehman securities. ISDA just had an auction to help settle the liabilities resulting from the Lehman CDSs. The net exposure - industry-wide - on Lehman CDSs was about $6 billion. That's for all participants in CDSs with respect to the largest bankruptcy in history. In other words, not even a drop in the bucket.

It doesn't surprise me that know-nothings will try to affix the blame, especially in an election season. But to blame CTMA is almost as moronic as blaming GLB - these acts had virtually nothing to do with the crisis (indeed GLB *helped mitigate* the crisis by allowing large solvent banks like Chase and BofA to buy up investment banks like Bear and Merrill).

Dilan: If we don't know how we got here, it's very hard to figure out where to go and to keep it from happening again. IF GLBA was not the problem, then "fixing" it is a non-solution.

FM/FM may not have created the market but they were the the accelerent. Their unslakable thirst for subprimes coupled with the ability to borrow ridiculous amounts of cash (because of implicit US backing) seems to be what turned a small-mediumish problem into an utter debacle. Hooray for moral hazard -- if I bet long and win, profit for me. But if I lose, well, the House (i.e. the US taxpayer) picks up the loss. Why not bet long?

Elliot123 - the banks are deadbeats that are not able to meet their obligations either, Lehman is already in bankruptcy and the other banks are only going to meet their obligations and avoid bankruptcy thanks to government intervention... do you think they get a pass? They made the same mistake as the homeowners, took out too much debt &failed to foresee the risk of doing so.

I have no problem with fixing things that need to be fixed, including any of our regulatory structures. (By the way, I should add that even if Gramm-Leach-Bliley didn't cause this, nobody has ever convinced me that Glass-Steagell was such a terrible idea-- what, exactly, is the extra value gained in merging commercial and investment banks?) The problem I have is the blame game. If someone wants to say "here's what's wrong with subprime lending and how to fix it", that's fine. If someone instead is saying "here's what's wrong with subprime lending and it's all the Democrats' (or Republicans') fault", that's not helpful at all.

Wallison's argument (Gramm-Leach-Bliley had nothing to do with the current problems) makes at least as much (or at least as little) sense as the NYT Editorial today "Misplaced Blame", which argues that the Community Reinvestment Act has nothing to do with the current problems. The NYT notes that the CRA was enacted in 1977 (but, fails to note the 1999 amendments and changes adopted by Fannie Mae and Freddie Mac in the past 10 years) to argue:

The charges do not hold up. First, how could a 30-plus-year-old law be responsible for a crisis that has occurred only in recent years? Then there's the fact that the regulatory guidance issued under the reinvestment act and other banking laws actually impose restraints on the riskiest kinds of subprime lending.

Maybe the truth is that there really aren't any economic problems today -- since no one and nothing is responsible, ipxi dixit, there can be no problem. Maybe we should all just go to Katie's restaurant in Wilmington, Del. -- the place that hasn't been there for over 20 years -- and talk to the people who aren't there, just like Sen. Biden does. That's where he gets his information on how working folks are doing these days. That's likely as good a source as either the NYT or WSJ are using.

Fannie/Freddie was the guy showing up at the party at 4 am with an 8-ball of coke. The party was well out of control by that point.

This.

FM/FM had a nice little racket business going up until 2004, when certain accounting irregularities were exposed and plunging headfirst into the subprime/alt-a mess, in the name of increasing homeownership, became the price imposed by Barney Frank &Co for letting them off the hook.

It's as though after being caught with your hand in the cookie jar, they were ordered to go to the party at 4 am with an 8-ball of coke as part of their community service.

This is the main reason I'm skeptical that government regulation can solve this sort of problem in the future. It asks me to believe that guys like Barney Frank, in the USA and overseas, will encourage future lenders to make credit terms on home buyers _tougher_ instead of easier.

The repeal allows investment banking and brokerage arms of the financial companies that were trying to sell new financial instruments to lean on the commercial baking side to extend credit to their customers. The investment bankers and brokers earn fees from these same customers. The commercial side by itself probably would not loan money to the hedge funds, so that they could leverage themselves up to 100:1 ratios just for the meagre interest income. It would be too risky. The additional fee income tips the scales, especially at banks where the investment banking arm is more influencial and the bonuses are structured for short term gains instead of long term health of the bank.

I don't know whether that repeal was beneficial or damaging in the end, but I believe it did influence the decision making process of the financial companies quite a bit.

Fannie and Freddie didn't create the subprime and alt A business, but they poured gasoline - make that napalm - on the fire. Does anyone doubt that if Fannie and Freddie had stuck to their original purpose - financing long-term fixed rate mortgates with substantial down payments - that the country would not now be in the middle of a financial crisis? If Fannie and Freddie had not financed $1 trillion of no-money-down and no-proof-of-income floating rate mortgages, there would have been no market of crappy securities passing that risk on to other buyers. It all started with the concept, pushed by the Government, of making home loans to poor people with bad credit.

The more I look at this the more "causes" I've seen (although I agree with Wallison on GLBA). Bad underwriting models, bad regulations, bad brokers, bad lenders, bad borrowers, bad Federal Reserve monetary policy, bad changes to the accounting rules--and I'm sure there are others. And it all managed to come together in a perfect storm to turn a problem into a crisis.

If Fannie and Freddie had not financed $1 trillion of no-money-down and no-proof-of-income floating rate mortgages

The GREs didn't enter this market until 2005....which was actually close to the end of the RE bubble. That's one of the reasons they crashed and burned so spectacularly. They bought the garbage at the tail when it was the most overpriced.

And the GREs didn't buy up _any_ of the idiotic mortgages &loans being issued overseas by banks and brokerages in the UK, Iceland, Belgium, Spain and Germany. The kool-aid was swallowed world wide, not just in the USA. In fact, it's increasingly looking like things may be even worse in Euroland than in this country.

Can we all agree that banks shouldn't be pressured to lend money to those with bad credit?

I propose that banks (which are federally insured) not be allowed to underwrite mortgages where the buyer can't come up with a 5% down payment. I know that this will keep some people from qualifying to buy a home, but those people should rent until they figure out how to save money.

Term limits for congressmen and senators also wouldn't be a bad idea. I can't think of a workable way to keep those who are on the government dole from contributing to those who steer the pork to them, so I say periodically kick all the bums out.

Can anyone tell me what idiot first thought no- (or only token-) money-down mortgages were a good idea? I can see how underqualified buyers eager for a chunk of the housing boom might bite, and I can see how lenders who were assured of their own ability to fob the loan off onto someone else before it got messy might collaborate, but someone must have pushed this bizarre idea for it to have gotten such general currency. To me it looks absolutely lunatic to lend someone huge sums w/o collateral of any kind, but maybe that's why I haven't made myself a fortune in the real estate market.

To Connecticut Lawyer, though: I'm house-hunting in Marin County, CA at the moment, &I see a lot of foreclosed-on stuff floating around that I guarantee you wasn't being sold to "poor people with bad credit" at any time. Everyone, it seems, was buying stuff they couldn't actually afford, with the (allegedly) sure prospect of selling it two years down the line at a handsome profit, before the rates reset and things got messy. Was this maybe a device designed to help "poor people with bad credit" that got taken up by everyone and anyone? Because that's what it looks like from here.

The real cause is unsupervised financial markets, and the sponsor of that very bad idea was Reaganomics.

Repealing Glass-Steagall was important in a symbolic way, in that it indicated to the money managers that they could operate like bucket shops and nobody would object -- until the crash, anyway.

By the time G-S was repealed, the institutions it covered had been eclipsed by newer, more dangerous organizations that had not been thought of in the New Deal. It should have been extended and expanded.

All unsupervised financial markets crash, every 6 to 20 years. During the period of adult supervision, which lasted six decades, there were no crashes.

Free markets in abstract financial instruments are suicidal.

I don't see a lot of VC posts linking the the Chicago Boyz lately, compared with times past. Why is that?

I'm with Dilan Esper (and that doesn't happen all that often). It seems to me that the causes of the current problem most definitely do NOT include:
Gramm/Leach/Bliley--it hasn't been the companies that combined commercial and investment banking that failed.
CTMA--credit default swaps are a very minor part of the problem.
accounting irregularities at Fannie and Freddie during the Clinton administration
lavish parties for AIG salesmen--though that sure is Congress's focus
high salaries for Wall Street execs--though that sure is Zywicki's and Bernstein's focus
the Community Reinvestment Act--it isn't inner city loans that are the source of the problem
excessively easy money--the Fed isn't responsible for credit spreads which shrunk steadily from 2002 to 2007. Also, the European Central Bank hasn't been so easy, but problems in Europe are just as bad.

In my view, imprudent mortgage lending and rating agency mistakes are the major culprits. I would suggest (i) that no GSE be permitted to buy a mortgage that didn't have a 20% downpayment and that no federally insured institution be permitted to originate or hold such a mortgage, or any securities backed by such mortgages. If private mortgage brokers want to set up a business selling such mortgages to hedge funds, that's fine.

Thanks to our policies, homeownership in America is at an all-time high. (Applause.) Tonight we set a new goal: seven million more affordable homes in the next 10 years so more American families will be able to open the door and say: Welcome to my home. (Applause.)

"Homeownership is central to the American dream, and Republicans want to make it more accessible for everyone. That starts with access to capital for entrepreneurs and access to credit for consumers. Our proposals for helping millions of low-income families move from renting to owning are detailed elsewhere in this platform as major elements in Governor Bush's program for a New Prosperity."

I propose that banks (which are federally insured) not be allowed to underwrite mortgages where the buyer can't come up with a 5% down payment.

5%? That's crazy. Banks should not be permitted to give out mortgages unless the buyer can pony up the customary 20% down payment. And not where that 20% comes from a HELOC or some other debt - I mean 20% real money.

Also, we ought to be banning ARMs and other crzy mortgages. Buyers can choose from 15-year fixed rate and 30-year fixed rate. That's it.

"Eliott, people have been buying mortgages and not paying them for a very very long time. Why is it *now* that somehow that is the only sole cause for this epic meltdown? Please."

Because more are doing it.

"Elliot123 - the banks are deadbeats that are not able to meet their obligations either, Lehman is already in bankruptcy and the other banks are only going to meet their obligations and avoid bankruptcy thanks to government intervention... do you think they get a pass?"

Of course not. Why should they? But I note we hear all kinds of analysis about credit default swaps, tranches, leverage, Glass Seagal, mark-to-market, Fannie Mae, Freddie Mac, Sarbanes-Oxley, and MBS, but very little about the good old American deadbeat sitting in his Lazy Boy watching his 42 inch plasma. What little we do hear trumpets his unbelievable stupidity: "The poor deadbeat was just doing what he was told to do."

Repealing Glass-Steagall was important in a symbolic way, in that it indicated to the money managers that they could operate like bucket shops and nobody would object -- until the crash, anyway.

This is what Right-Wing talking point repeaters claim about the CRA when confronted with...umm...actual facts: That the CRA created a certain climate.

Bovine fecal material.

Before Gramm-Leach, operators that wanted to avoid Glass-Steagall just opened up a subsidiary offshore, in a shady, ungoverned location like London or Brussels. Anyone actually interested in getting out from under Glass-Steagall
had already done so years earlier.

The primary motivation of Gramm-Leach was not to make life easier for multinational finance corporations. Life was already easy...elsewhere. It was to encourage operators to employ people in NYC as well as London.

There were undoubtedly many loans that should not have been made. But reasonable loans default sometimes also. Not all the defaults by any means were idiotic transactions to begin with.

Once you have defaults, and securitization, and companies using leverage to buy the MBS, the stability of the system is highly dependent on accurately valuing the mortgages and securities. That is, if you're going to borrow a ton of money to buy mortgages, or MBS, and you get the default rates wrong, for example, it's not going to matter much if the underlying mortgages are sound. Push to the edge, and misjudge, and you're off the cliff.

You could buy a portfolio of 30-year, fixed-rate, 20% down payment mortgages, and if you overleverage because your model mispriced the mortgages, you're done.

And none of the banks that have major securities affiliates — Citibank, Bank of America, and J.P. Morgan Chase, to name a few — are among the banks that have thus far encountered serious financial problems.

A.S.: In your dismissal of CDS written on Lehman as not significantly related to the fall of Lehman, you may well be correct. However, you overlook that another huge financial event of recent days, the fall of AIG, was in fact caused by huge CDS exposure written *by* (i.e. not on the debt of) AIG. If the government had not intervened, the large insurance giant would have collapsed catastrophically, and brought down its sounder regular insurance businesses as well. Unregulated CDS are a huge problem, allowing investment banks to rack up huge, unsustainable leverage. They were written on mortgage-backed securities but are really related to all kinds of credit risks, and there's a lurking balance of payments and physical settlement problem with the shadowy (I don't mean evil, just not transparent) market. It is this kind of binge borrowing and amplified leverage, as well as CDS linking everything together, that made essentially every big bank vulnerable to the systemic risk of too much debt and easy credit. The bursting of the housing bubble and failure of some subprime MBS was merely one aspect of a fundamental problem, and it is indeed silly to blame the Community Reinvestment Act, or even Freddie and Fannie, bad as they are, for the current mess--the facts simply don't bear out that that statute or the GSEs had a significant connection to the subprime mess. Indeed, the GSEs would not buy subprime mortgages or MBS for the most part, unlike many other institutional investors.

'It was to encourage operators to employ people in NYC as well as London.'

Yeah, I remember Gramm saying that.

Come on, some us weren't found yesterday under a cabbage leaf. Since 1980 and before, it's all been about 'maximizing profit potential,' 'unlocking shareholder value,' 'getting inhibiting regulations off the statute books' and 'unleashing the power of the market.'

Come on, some us weren't found yesterday under a cabbage leaf. Since 1980 and before, it's all been about 'maximizing profit potential,' 'unlocking shareholder value,' 'getting inhibiting regulations off the statute books' and 'unleashing the power of the market.'

Well, it's been unleashed. How do you like them apples?

When you can't argue the law or the facts, you pound the table. But it's still in support of a fairy tale.

If you want me to believe regulation could have avoided this mess, you have to convince me regulatory agencies and their elected overseers will act to make it harder for people to obtain home financing, instead of easier. And that they will then maintain this stance over the long haul.

They won't. Whether the politicians involved are Democrats or Republicans. Labour or Tories. Social Democrat or Christian Democrat. Evidence to that effect is currently pouring in from all over Europe as well as the good ole USA.

It's obvious that better regulation would have prevented this crisis. It's also obvious what the form of that regulation should have been: No federally insured bank or financial institution or federally sponsored entity (Fannie, Freddie, Ginnie, etc.) may finance, directly or indirectly (including through the purchase of MBSs), any mortgage except for fixed-rate, 10-30 year mortgages with substantial down payments (I think 10% would be OK on a 10-year loan; 20% for longer loans). As someone up thread noted, if purely private mortgage companies want to offer something else, well, it's their money.

Here's a follow-up question: Could this legislation pass Congress today? Why not? (Hint: Their last names are Frank and Dodd.)

Well, if nothing else, c.gray's posts offer a smile a day. The idea that Phil Gramm acted in order to prevent offshoring American jobs, for example.

'How should we deal with profit potential, shareholder value, inhibiting regualtion, and the power of the market?'

I liked the New Deal ideas: modest restrictions on the inherent tendency of unsupervised markets to act like a turbocharger (the faster it goes, the faster it goes, up to when it disintegrates).

Both Republicans and Democrats are now blaming 'greed, just plain greed' (quoting the Republican governor of my state, for example). But how does greed differ from maximizing profit potential?

The problem with maximizing profit potential and with free markets in general is that you get what the market gives, whether, after you've got it, you wanted it or not.

As people like c.gray so eloquently demonstrate, it wasn't American regulations that caused offshore markets to behave like . . . well, like markets.

The Glass-Steagall restrictions certainly allowed US banks and investment banks to make lots and lots of money. They may perhaps have dampened the annual profit in some years. As the market heads down and down (to, I suspect, a crash), it becomes less and less obvious that the anti-GS approach really does maximize profits over any span longer than a decade or so.

"The Glass-Steagall restrictions certainly allowed US banks and investment banks to make lots and lots of money. They may perhaps have dampened the annual profit in some years. As the market heads down and down (to, I suspect, a crash), it becomes less and less obvious that the anti-GS approach really does maximize profits over any span longer than a decade or so."

How did allowing both commercial and investment banks to be owned by the same holding company cause a problem?

And your posts, while giving us excellent insight into your opinions on the virtues of the New Deal regulations, and an excellent repetition of "progressive" talking points, are devoid of any facts, any theory, or even a single wild-ass guess, purporting to explain how Glass-Steagall would have saved us from the current crisis, or even how the repeal of some its provisions contributed to the crisis.

That's because you can't. There are no facts to back it up. In actual fact, permitting commercial banks to buy out the troubled investment banks is helping to mitigate the current crisis. While this may well be saving up trouble for a future day, it has nothing to do with the problem the financial industry currently faces.

You, and others like you, are the mirror-image of the "conservatives" nattering on about the CRA. Neither group has an argument that can withstand even minimal exposure to an actual examination of the facts. That's a sign neither really cares about the truth. Each group just wants the emotional satisfaction of blaming their favorite bugaboo for everything, truth be damned.

Well, good luck with that. When confronted with a serious crisis, it might be cathartic to select a jet-black goat and sacrifice it to one's gods, but doing so is not likely to provide a constructive set of solutions.

It's obvious that better regulation would have prevented this crisis. It's also obvious what the form of that regulation should have been:

As I noted above, I think there is way too much emphasis being placed on the quality of the mortgages. Investors make money - boxcars of it - investing in risky securities all the time. Think of successful VC firms, for example. The trick is to get the financing and the pricing right.

Getting the pricing right is very difficult, though more transparency in the market would help. That's one advantage of bringing things into exchanges, though I don't know if that can be done. It seems clear that the model approach introduces new elements of risk. Getting the financing right requires, maybe, a much more conservative approach, in terms of leverage, capital requirements, etc.

Well, yeah, but I don't think you need a slide rule to 'get the pricing right' on a scheme that is leveraged 30:1. I can figure out in my little pea brain that unless the economy is never subject to swings greater than 6%, you're bust in the long run.

The idea that paying commercial banks (or anybody else) trillions of dollars to take over sour paper is 'helping' is another c.gray smile a day.

Thanks, c.gray.

G-S as written 60 years ago obviously wouldn't have done anything. Even extending it to US non-bank banks would not certainly have helped, given the fact that hot money does not readily recognize international borders.

It would, however, have firewalled commercial banks from the wilder ranges of free-market finance capitalism, so that the crash of, say, Bear Stearns would have had no more effect than the crash of, say, WorldCom.

There's a reason we had finance panics every 6 to 20 years through '29, then a drought for six decades, and now a return of panics.

I think it was New Deal-style adult supervision. If you have a different explanation, I'd like to hear it.